Pound-to-Dollar Week Ahead: Charts Point Higher as Risk Appetite, Brexit Talks Key to Outlook

- GBP/USD snaps losing streak and looks to recover further.
- But BoE rate chatter could unsettle GBP early in new week.
- As mini budget and Brexit talks dominate mid-week agenda.
- Recent low at 1.2260, 200-day average near 1.26 in focus.

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The Pound-to-Dollar exchange rates recovered sharply off June lows last week and could have legs to extend higher in the coming days though appetite for Sterling will be tested by domestic developments multiple times.

Sterling interrupted a three-week run of losses against the Dollar last week although it owes much of its good fortune to the rising tide elsewhere in the financial markets than any changes in domestic fundamentals. 

The Pound was under pressure early on after Prime Minister Boris Johnson revived the threat of a 'no deal' Brexit but the sell-off petered out near 1.2260 before giving way to a recovery. Sterling's fortune was aided by weakness in the Dollar, which was sold heavily until Thursday when the looming Independence Day public holiday appeared to prompt profit-taking. 

"We’ve seen GBP/USD get down close to the 1.2250 level but we have rallied this week with the broad sell-off of the dollar. While we hold less conviction of an imminent risk-off episode unfolding over the short-term than we did when we established this, we will stick with this trade idea for now. We have however raised the take-profit level to the levels we reached earlier this week," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

Appetite for the British currency will be tested at the open on Sunday and over the course of Monday when investors will have an opportunity to respond to a Sunday Times report revealing the Bank of England (BoE) has been in contact with commercial lenders to warn them about the costs of a possible shift to a negative interest rate policy further down the line. 

The BoE has broached the subject repeatedly of late, prompting weakness in Sterling in most instances so the Pound-to-Dollar rate might be likely to find itself on the back foot initially at least. Other risk events include a mini budget from Chancellor Rishi Sunak and another update on the Brexit trade talks but if after all of this last week's low near 1.2250 is left intact then it would be a further indication of a short-term bottom forming for Sterling. 

Above: GBP/USD at daily intervals with S&P 500 index futures (orange line), DAX index futures (black) & moving-averages.

Halpenny and the MUFG team were unimpressed last week by Boris Johnson's plan to bring forward £5bn of already-announced infrastructure spending into the current year give than it represents barely 0.25% of GDP, and are also sceptical that anything announced by Chancellor Sunak on Wednesday will be enough to fundamentally improve the big picture for Sterling, which is still on of economic wreckage overshadowed by a cloud of Brexit uncertainty. 

"Daily correlations between FX and S&P 500 remain very high but not on a DXY basis due to the low EUR correlation. But NZD, AUD, GBP and CAD have correlations close to 0.90 since the start of the year. However, correlations are stronger over a 3mth period, including for EUR and we see no reason for this dynamic to change," Halpenny says. "While risk may hold up over the short-term, we see reason for GBP to underperform."

The upbeat mood has endured and lifted Sterling even as the U.S. economy reported repeated new records for new coronavirus infections last week, with investors preferring to trade the global recovery narrative in anticipation of a second half global economic rebound. Meanwhile, the resulting price action has left its mark on the charts and led technical analysts to look for a continued recovery in the Pound-to-Dollar rate over the coming days. 

"GBP/USD has recovered from the 1.2251 late June low and targets the 1.2643/86 resistance area which consists of the April highs and the 200 day moving average. There it is likely to at least short-term stall," says Axel Rudolph, an analyst at Commerzbank. "Above the 200 day moving average at 1.2686 sits the June peak at 1.2814. Minor support can be seen along the 55 day moving average at 1.2415 and also along the March-to-July support line at 1.2282."

The markets irrepressible appetite to risk assets and an apparent growing bias among Americans to sell Dollars has lifted the Pound-to-Dollar rate in the last week, enabling it to navigate withouth significant upset no less than three separate instances in which PM Johnson either threatened an Australia style trading relationship with the EU, otherwise known as one governed by World Trade Organization terms, or extolled the perceived merits of one.

Above: Pound-to-Dollar rate at daily intervals with Fibonacci retracements of March fall and selected moving-averages. 

"The GBP will now depend on whether a political declaration between the two sides can be crafted by the final week of July. The relatively short time span between now and then could reduce investors' appetite to maintain sizable exposures in both GBPUSD and EURGBP. This may leave the former a lot more dependent on risk appetite variables, like global equities. A further bid in global equities may not be enough to force a close below 0.90 in EURGBP yet. But it could be enough to force a re-test of 1.2600 in GBPUSD," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. 

The Brexit talks are at a crucial juncture and will be a key focus this week but before then Sterling will take cues from Wednesday's mini budget.

Chancellor Rishi Sunak is expected to announce fiscal measures aimed at jump starting the economy Wednesday after pubs and restaurants were allowed to open on Saturday for the first time since March, largely completing the domestic exit from 'lockdown'.. It's not clear how the Chancellor will aid the economy but his announcement comes after Boris Johnson's infrastructure plan went down like a damp squib with investors last week.

"We think that sterling is not reflecting the substantial weakness in the economy we foresee, especially not versus the US dollar. We expect a decline in GBP/USD in the coming months towards 1.20 on the back of risk-off and a downshift in expectations about the UK economy," says Georgette Boele, a senior FX strategist at ABN Amro. "We still expect a sustained period of risk off over the next three months. This should support the US dollar."

Any budget-induced upside in Sterling will either be constrained or augmented in the final session of the week when updates are expected from Brexit negotiators, and that's assuming the Pound hasn't been wobbled or the Dollar lifted by an ebbing of risk appetite, which will be impacted by coronvirus infection numbers, economic data, fiscal policy announcements and geopolitical tensions. Investors will watch Monday's 15:00 ISM non-manufacturing PMI in the U.S. closely for signs of curtailment in the barometer's recovery that could be attributed to the second wave of coronavirus sweeping across the U.S.

"Several recently published surveys on the UK economy provide grim reading," says Jane Foley, a senior FX strategist at Rabobank. "When this backdrop is layered on top of Brexit uncertainty and the ongoing discussion about negative interest rates in the UK it is little surprise that the pound has been the worst performing G10 currency over the past month. Looking ahead, both economic and Brexit discussions are likely to feature heavily in the performance of the pound. The longer investors have to wait for signs of compromise from Brexit negotiators, the more chance there is that GBP will slip lower." 

Above: Dollar Index at daily intervals with S&P 500 index futures (orange line), DAX index futures (black) & moving-averages.